Apple, to eat or not to eat?
Updated: Feb 22
Shitting on the world's most popular stock often does not end well for me. It always ends up with a flurry of angry bulls responses that can be categorized into mainly 2 camps 1) Apple got so much cash!!!!!!! 2) Buffett is still holding!!!!!
Most responses are a regurgitation of popular opinion on the internet of why Apple is a buy... 5 years ago.
Disclaimer: I have no position on Apple, long or short, ... for now.
The first year-over-year decline in Sales since 2019. The revenue drop 5% compared to 2022's revenue.
iPhone sales are down 8.17%. This is significant because almost 55% of Apple's revenue comes from iPhone sales
Service revenue is up 6.4%. This is the only good news for Apple's earnings as Service revenue makes up approximately 20% of Apple's total revenue.
Apple attributes the poor sales to 3 key factors; the Foxconn protest in China resulted in unable to meet production targets and customer demand, the strong dollar, and macroeconomic headwinds.
I will proceed to explain why those 2 out of the 3 key factors are not the reason why Apple performs poorly. There is only one simple reason why Apple did not do well; there is lesser demand.
Let's get the obvious one out of the way; macroeconomic headwind
Macroeconomic headwinds have been the bane of corporate earnings for the entire of 2022. This has mainly to do with higher interest rates and inflation. Inflations have caused the cost of goods sold (COGS) and operational expenses (OPEX) to rise drastically, pressuring profit margins.
However, this is a worldwide issue and it is not specific to Apple alone.
1. Foxconn protest, lockdown, zero-covid, supply chain.
This is the first automatic defense for explaining the revenue decline. No doubt, this would definitely slow down the production of iPhones. The key question is; was there sufficient demand in the first place for Apple to recognize those sales if production was not disrupted?
Note Apple is already cutting iPhone production primarily due to softer demand as early as November.
If demand is so high that Apple could sell every single one of the iPhones assembled, then we should see a sharp decline in inventories.
However, we are seeing a sharp increase in inventory during the holiday season (4Q2022) compared to the previous quarter (3Q2022); $6.82 billion worth of components and finished goods.
A further breakdown revealed $4.3 billion worth of products sitting in the warehouse.
This is the highest inventory level based on the data available (2014 to current). The inventory exceed 2021's number when the supply chain was much more problematic.
So, did the China lockdown cause a decline in iPhone sales? Yes.
Did weaker demand cause a decline in iPhone sales? Even bigger yes. Note: Apple used to have a limit on the number of iPhone purchases per customer on their official site. It seems that the limit was removed. I was able to place an order for 100 units of iPhone 14 pro-Max and got it through the system. The official website will decline your order if they have limited inventory but mine got through. Of course, my credit card was declined. This is an anecdotal experience, not to be taken seriously.
2. Strong Dollar and FX Headwind.
This is not hard to debunk.
Dollar Index (DXY) actually peaked on 28 Sep 2022, right before 4Q2022.
Dollar/Yuan peaked one month later around 01 Nov 2022 and then saw a steep decline for the remainder of 2022.
The dollar was actually easing for 4Q2022 and should have provided some boost to the top line. The dollar was much higher in 3Q2022, and Apple was still able to generate 8.14% revenue growth for that period.
It is not to say that the zero covid lockdown and the strong dollar have no impact on Apple's revenue decline. They do impact, just not as much as weaker demand.
Onto a trickier topic.
Apple is a cash cow and spends most of its cash on share buybacks, which is generally considered good news for investors.
In 2016, Apple spent $29.7 Billion on share buybacks. In 2022, Apple spent $89.4 Billion on share buyback.
When a company initiates a share buyback it reduces the number of the company's freely trading shares.
What this does is, it will artificially increase the Earning Per Share (EPS) value even if there is no increase in Net Income.
For example: 1Q2023 Net Income: $200
No. of shares: 100
Share buyback commences, shrinking the floating share from 100 to 90.
Net Income: $180
No. of shares: 90
You can see that even though 2Q2023 earnings went down by $20, the EPS is still the same due to shares buyback. Now, this is generally not an issue if the company is doing well and it is growing as expected. Buying back its own share increase shareholder value. However, if the company's growth and earnings have slowed down significantly, the effect of share buyback can mask the problem that the company is facing. It can lead investors to make the wrong decision. The cash that is spent on the share buybacks could have been better spent to materially improve the company.
Look at the 2022 result. Revenue shrank from 33.44% growth in 2021 to only 7.79% growth. Net Income shrank from 64.92% growth to only 5.41% growth. 2023 might be worse. Note that Apple is valued as a growth company. Investors buy Apple for future growth. What we are seeing now, is a threat to growth.
Apple's cash holdings have also declined since 1Q2022 because most of it has been spent on share buyback when their earning growth is actually hurting.
It seems that Apple's share price is propped up by share buybacks, while the underlying growth of Apple is deteriorating. Still, Apple has sufficient cash to continue its share buyback program until the macroeconomic environment improves. However, note that Apple is valued as growth, if shareholders no longer see a growth story for Apple, they may start to ditch their shares. Share buybacks add shareholder value to an already strong company. It does not create value for a company going ex-growth.
But.. Buffett still owns APplee. hurdurdurdur Being a bear in 2022 was tough. Buffett has been name-dropped to me countless times but the name-droppers could not conjure up any worthwhile argument aside from generic Buffet quotes like
"Buy when everyone is fearful" "Don't bet against America" I have studied Buffett's methodology and I personally follow the majority of Buffett's teaching. It's funny because the name-droppers are the one who seems to be misinterpreting Buffett's method. As of 30 Sep 2022, Buffett owns 915 million Apple shares which accounts for 40% of the total Berkshire Hathway portfolio. There has been no significant increment in Apple share holding since 2021.
With 40% weightage, I highly doubt Buffett will add any more significant holdings to Apple.
If Apple's cash flow and the ability to buy back shares are threatened, you may see Buffett unloading Apple. He probably has identified a new growth company to become his new Apple already. The risk of Buffett dumping Apple is much higher than adding or holding. Berkshire's holding is only reported once every quarter, hence it cannot be used as an entry signal for trade.
The Line Goes up
Here comes the most annoying part. Well, the line is up, so none of the fundamentals matter.
Apple is quite notorious for rallying on bad earnings only to sell down a few weeks later.
The rally on Apple and the overall market was primarily led by the expectation of the Fed's Pivot and also the weaker dollar. With the recent ISM Non-manufacturing and NFP data, the Dollar Index (DXY) found support at the 101.192 level and has rebounded.
If Dollar continues to gain some ground and rallies, it will pressure Apple's future earnings and its share price.
The 10-year treasury yield has also found support around the 3.3 - 3.4% level. High yield and the strong dollar are generally bad for growth Tech Stocks.
Apple closed at 154.5 on Friday, 03 Feb 2023. It is only down 13.37% from its all-time high price. It is quite disconnected from the huge slowdown in Apple's revenue growth.
158 is the current resistance and 177 is the next resistance. The current price action is obviously very bullish. I would prefer the price to go below 145.50 before I make any trade decision.
There has to be a strong catalyst to significantly drive Apple down further. It can be
Halting share buybacks
Sales and Net Income to decline further
Buffett dumping his holding
All of the above.
Apple's growth is deteriorating; partly due to zero covid, primarily due to lack of demand
Dollar and Yield rebounding is a threat to Apple
Not a buy
I may trade for the downside in the future. Most likely with a put option rather than short selling
Update 17 Feb 2023: We are current short Apple via Put Option ---------------------------------------------------------
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